It’s commonly believed that Americans face a “retirement crisis” – Social Security is too stingy and we’re not saving enough for retirement on our own. I looked at the “Social Security is stingy” claim in a recent article on replacement rates paid by the program. But one other reason many conclude there’s a retirement crisis is that they simply set the bar too high for what counts as an adequate retirement income. A new study from
Fidelity projects that only about 45% of Americans are currently on track to cover their essential expenses in retirement. Breaking things down, Fidelity estimates that 27% of Americans will be able to cover more than 95% of their total retirement expenses; 18% will be able to cover essential expenses but not luxuries like travel or entertainment; 23% will need to make modest adjustments to meet essential retirement costs; and 32% will need to save significantly more just to afford the bare essentials in retirement. So far, consistent with everything else you read – broadly speaking, we’re in trouble.
But what does it mean to have enough to retire on? Fidelity recommends that individuals looking to cover at least the essentials seek to retire with savings equal to 10 times their final salary. To meet this goal would require Americans save somewhere upward of 15% of their annual salaries for retirement. In some ways I appreciate this “10x rule” – it makes it easier to set goals for their retirement savings. But for most Americans Fidelity’s 10x rule will vastly overstate what they need to save for retirement.
I’ll illustrate using stylized earnings patterns created by the Social Security administration for workers whose earnings are categorized as low (averaging about half the national average wage each year), medium (about the average wage), high (about 1.6 times the average wage) and maximum, which means you earn the maximum wage subject to social Security taxes (currently $118,500) every year of your life.
For each earnings type, I find their Social Security benefit at age 67, the age at which Fidelity says their 10x rule applies. I also calculate the income they would receive from their 10x savings, which Fidelity recommends retirees can safely withdraw at 4.5% each year. I add those two numbers together to find the person’s total retirement income, then compare it to their final salary to calculate a replacement rate.
Most financial advisors recommend that people have a retirement income equal to about 70% of their pre-retirement earnings – that is, a 70% replacement rate. But following Fidelity’s 10x rule, an average wage worker would retire with a total income equal to about 107% of his final earnings. A low earner would receive a replacement rate of 129% of final pay. When you consider that retirees pay lower taxes and have no need to save for retirement – something which under Fidelity’s rule would significantly reduce pre-retirement take-home pay – a typical person following Fidelity's advice would experience a significant uptick in their standard of living once they retire.
At best, following these rules could lead some Americans to over-save, which can make it more difficult for them to buy things they need during their working years, such as a home or a college education for their kids. At worst, these findings and others like them could lead to politicians expanding Social Security, despite the program’s unfunded obligations rising by over $5 trillion in the last 8 years.
Even a person who earned the maximum taxable Social Security wage of $118,500 each year of his life – a person who’s very uncommon – would receive a replacement rate of 74% of final pay. Most guidelines assume that high earners requirement lower replacement rates, somewhere in the mid-60s, so you’d have to be a very high lifetime earner before the Fidelity rules gave you a retirement income in line with what financial planners recommend.
I understand why Fidelity and others make these kinds of recommendations: For one, they’re in the business of selling retirement investments. I also believe they honestly think Americans should save more. And some percentage of us certainly should. And in a country of 300 million people, even a modest percentage is a lot of people falling short.
But saving for retirement isn’t a morality play where we show how good we are by putting off enjoyment today in order to buy more cruises and dinner theater once we decamp for Florida. It’s about arranging our finances to maintain a steady standard of living over the course of our lives, both from year to year and between our work years and retirement. Retirement matters, but your youth and middle age matter, too.
Yes, if Americans need a higher income in retirement than they had while they were working, we’re facing some challenges in retirement saving. But almost no one believes that’s what people should aim for. Setting the bar too high might discourage people, or it might convince them that the only way that Americans can retire in dignity is for the federal government to expand Social Security. That’s just not true and it’s not helpful to put retirement saving in that light.
